Continued from page 11
Regulation D of the Securities Act of 1933, as amended (the
“1933 Act”) which covers sales to “accredited investors,” and
Regulation S under the 1933 Act, which covers sales directed
to persons outside the United States. Offerings that comply
with these regulations would generally not be considered public
offerings.8 To the extent that an EB-5 fund engages outside agents
to market the fund it must be careful that the activities in which
the agents engage do not result in the fund being deemed to be
engaged in an unregistered public offering, both because of the
potential impact on the § 3(c)(1) exemption and because that
may result in the right of investors to rescind their investment.
“Let Me Tell You About the Very Rich. They Are
Different From You and Me.”9
Section 3(c)(7) of the 1940 Act exempts a fund from the
definition of investment company if all of its security holders are
“qualified purchasers,” generally defined as a person owning at
least $5,000,000 in investments either individually or with his or
her spouse. Any fund that qualifies for the § 3(c)(7) exemption
would not be integrated with funds seeking to use the § 3(c)(1)
exemption. Accordingly, it is possible to create a fund or funds
parallel to a fund using the § 3(c)(1) exemption that is limited
to qualified purchasers which would allow the § 3(c)(1) fund to
meet the 100-investor test. However, it may be difficult to find
sufficient investors that met the qualified purchaser standard and
the persons marketing EB-5 fund investments may not want
to take the extra step of verifying compliance with the qualified
purchaser standard.
“I Just Love Real Estate”10
Section 3(c)(5) of the 1940 Act also exempts from the
definition of “investment company” an entity purchasing
or otherwise acquiring mortgages and other liens on and
interests in real estate. The SEC has interpreted this to include
companies that make loans which are “fully secured” by
interests in real estate. Through no-action letters, the SEC has
opined that in order to be fully secured, the value of the real
estate collateral must be at least equal to 100 percent of the
principal amount of the loan at the time the loan is made.
Where the security interest is subordinate to another loan, the
value of the real estate must be at least equal to 100 percent
of the aggregate principal loan made by the company seeking
the exemption and the senior loan.11 In some of the no-action
letters on the topic, the lender confirmed the value of the real
estate with a third-party appraisal. The Capital Trust letter
cited in the footnote is particularly notable because the SEC
approved a structure where the loan was not directly secured
by real estate. Instead, it was secured by a pledge of interests
in a company that held real estate, with the value of the real
estate both exceeding the first mortgages directly secured by
the real estate and the mezzanine loan secured by the interests
in the company. The SEC took the position that, after taking
a number of factors into account, the mezzanine loan was the
functional equivalent of a second mortgage directly secured by
a security interest in the property.
12
“What! Me Worry?”1 2
Investment companies are subject to a number of operational
and reporting requirements under the 1940 Act ranging from the
composition of their boards to providing periodic, and public,
reports. These requirements would substantially increase the
costs of operating an EB-5 fund. In addition, § 47 of the 1940
Act provides that any contracts made in violation of the ICA are
unenforceable and subject to rescission. In addition, § 7 of the
1940 Act expressly prohibits an unregistered investment company
from offering its securities for sale in interstate commerce. As
a result, if an EB-5 fund were to become an inadvertent, and
unregistered, investment company, the investors in the fund
would likely have the right to rescind their investment and
request the return of their money. While, as a practical matter, the
investors may not be inclined to do so, so long as the investment
is progressing and they appear on track for their green cards, given
that they have a potential legal right to rescind the investment
and receive a guaranteed return of capital may lead the USCIS
to conclude that their investments are not “at risk” and that as a
result the investors are not qualified for the EB-5 program. In addition, if an EB-5 fund is found to be an investment company, its
manager or general partner may be deemed an investment adviser
to an investment company and thus be required to register as an
investment adviser under the Investment Advisers Act of 1940,
rendering the manager or general partner subject to significant
regulatory requirements, including ongoing reporting obligations
and restrictions on operations.
“And in the End”13
Recent SEC enforcement actions against EB-5 funds and
certain of their principals14 have made claims under virtually every
aspect of the securities laws, unregistered offerings, unregistered
investment advisers and unregistered broker-dealers, except, as
far as we know, the 1940 Act. This does not mean that the SEC
will not direct its attention to the ICA in the future. Substantial,
unpleasant consequences follow a material failure to comply with
the 1940 Act. Nonetheless, various bright line tests discussed
above, if followed, should allow EB-5 funds to be exempt from
the provisions of the 1940 Act. Thus, EB-5 funds should take care
and seek competent EB-5 securities counsel when preparing their
structure to fall within one of the exemptions under the 1940 Act.
Otherwise, they may well find that they’re “caught in a trap” and
“can’t walk out.”15
★
Mark Katzoff
EB5 INVESTORS MAGAZINE
Mark Katzoff is senior counsel in the corporate
practice at Seyfarth Shaw LLP, and he is a
member of the firm’s Capital Markets and EB-5
practices. He focuses his practice on EB-5 transactions and capital markets. Katzoff’s EB-5 practice focuses on the securities and compliance
aspects of EB-5 offerings, including compliance
with the Investment Company and Investment
Advisers Act and the broker-dealer provisions of
the Securities Exchange Act. Katzoff also advises
broker-dealers with regulatory compliance
matters.